In the Risk Outlook, Finanstilsynet emphasises that banks and insurance companies must factor in the great uncertainty that still attends the future path of the Covid-19 pandemic and its economic impact. Banks’ loan losses have risen as a result of the crisis. However, the increase is moderate thus far and largely refers to oil-related loans. As major parts of the business sector have experienced a significant decline in income, there is a risk that potential losses may be underestimated in banks' loss allowances. High house prices and a high debt burden in the household sector represent significant systemic risk. Despite the crisis, there has been a steep rise in house prices in recent months parallel to stronger growth in household debt, partly driven by record-low interest rates.
Just like the rest of the world, Norway experienced an abrupt and sharp economic downturn when the Covid-19 pandemic triggered strict containment measures and extensive lockdowns in the spring. Lower contagion rates provided the basis for a gradual reopening of society through the summer. During the autumn, several countries have once again experienced a surge in the number of infected people.
“Further developments in both the Norwegian and international economy are uncertain and will largely depend on the path of the contagion. Access to vaccines will gradually provide a basis for lifting the comprehensive containment measures. Nevertheless, it may be long before economic activity returns to pre-pandemic levels. Some industries may also face lasting changes in demand. Banks and insurance undertakings must therefore factor in the possibility of a deep and prolonged crisis,” says Morten Baltzersen, Director General.
The debt burden of Norwegian households is at a very high level both historically and compared to other countries and constitutes a significant vulnerability for the Norwegian economy. The growth in household debt has slowed somewhat in recent years, but has picked up since the summer. This year's residential mortgage lending survey shows that a large and increasing proportion of new mortgages is taken out by borrowers with high total debt relative to income. Several borrowers also have large mortgages relative to their property’s market value.
There was a slight increase in house prices in both March and April 2020, followed by a rising annual growth rate. In October, 12-month growth was 7.1 per cent. which is clearly higher than in the preceding years. As a result of low interest rates, increasing house prices and weaker growth in household income, households’ total debt relative to income may grow further in the period ahead.
“High debt levels make a number of households vulnerable to declining incomes, rising interest rates and falling house prices,” says Morten Baltzersen.
The volume of consumer loans, which grew rapidly for many years, is now declining sharply. There could be several reasons for this. In addition to the economic setback, the introduction of debt registers is probably a contributing factor. An increasing number of loan applications from customers with weak debt servicing capacity are now rejected, as institutions have a better overview of the customer's finances. Parallel to this, the share of non-performing consumer loans is still on the rise.
The Norwegian business sector is to varying degrees affected by the Covid-19 pandemic, the contention measures and the fall in oil prices. Extensive government measures have helped to keep up the level of economic activity in Norway and limited the decline in income for those parts of the business sector that have been most severely affected. Deferred payment of direct and indirect taxes and instalment payment deferrals on bank loans have improved many companies’ liquidity situation.
The banks' regulatory capital adequacy ratio is high and has risen over the past year. However, this increase can largely be attributed to regulatory changes that do not imply an actual improvement in the banks' financial soundness. Experience from previous crises has also shown that it may take time for the loan losses to be recognised in full in the banks' financial statements. The banks must therefore factor in the possibility of a significant rise in loan losses in the coming period.
“The great uncertainty indicates that the banks should maintain their equity base by retaining profits to ensure that they are well able to provide loans to creditworthy customers even in a situation with high loan losses,” says Morten Baltzersen.
Pension institutions' performance was severely affected by the fall in equity prices in the spring of 2020. Subsequent strong price increases gave a certain improvement in profits, but the return on the institutions’ collective portfolios for the first three quarters of the year is nevertheless weaker than in the corresponding period of 2019. The decline in interest rates makes it challenging to achieve excess returns on guaranteed rate products. Pension institutions have sizeable commercial property investments. Reduced demand for office space, hotel accommodation and to some degree shop premises weakens the current earnings of commercial property companies and may lead to lower property values.
As from 2021, 1.5 million Norwegians who have defined-contribution pensions will get an individual pension account. The aim is to give individuals a better overview of their pensions and to reduce total costs. The scheme may lead to intensified competition and lower prices in the defined-contribution pension market. The introduction may result in extensive transfers of assets between different managers of pension products, and it is important that the institutions have a good infrastructure for handling such transfers without delay and with minimal operational risk.
Overall, non-life insurers enjoy a sound level of profits in spite of the fact that some undertakings have experienced a increase in claims payments related to travel insurance this year. Favourable winter conditions and corona-related reductions in car travel and rush hour traffic have given a rise in profitability within motor vehicle insurance.
The Paris Agreement’s aim to mitigate climate change requires a fundamental restructuring of global energy use. For financial institutions and investors, it is important to gain good insight into companies' exposure to transition risk. Finanstilsynet’s survey of listed companies' sustainability reporting shows that Norwegian companies provide little information about the risk of changes in future profit levels as a result of the transition to a low emission society. Finanstilsynet will follow up companies’ future sustainability reporting.
Internationally, a number of processes are underway to establish classification systems for green investment products and ensure that investors and lenders receive the necessary information.
“Finanstilsynet will contribute to ensuring that relevant EU legislation is implemented in Norwegian law and will follow up the institutions' adaptations to new regulations in this area,” says Morten Baltzersen.